Sunday, June 14, 2015

There as
successful businesses, and they create an aura around themselves, become
subjects of case studies and help us to build theories. And there are enigmatic
business that have a mystery around them, raise the curiosity leave us
guessing. We do not know whether these enigmatic businesses have been innovative
and path breaking or just plain unethical or illegal. Sahara was always perceived
as a business shrouded in mystery with several conspiracy theories doing the
rounds on its sources of funding and its business practices.

Tamal
Bandyopadhyay’s book on Sahara is as close as it could get to prying open the
lid. It does not reveal much; does not tell the untold story in detail, but has
information, events, conversations and exchanges that attempt to tell us what
it could be. Even this small prying of the lid was not acceptable to Sahara.
They filed a defamation case against the publisher and author, which was eventually
settled with a two page disclaimer that indicates that the book is part
fiction. Whether this prominently displayed disclaimer was in itself a
marketing tool can be discussed by experts, but the buzz around the controversy
was enough to raise the levels of curiosity about the explosive stuff that the
book could have had.

Bandyopadhyay
writes carefully and meticulously. He pieces together information, interviews
and research, done painstakingly over the years and presents it in a readable
style. He adds drama – makes it appear like a participant-observer giving
details of the venues, almost verbatim reporting of what was said and the exact
timings of when text messages were exchanged. That adds to the readability of the
book, without much distraction.

There are two
strands in the Sahara story that Bandyopadhyay weaves together. The first
strand is the structural issues where the regulator’s concerns about Residuary
Non Banking Finance Companies (RNBC) are discussed. As a supplement he also
discusses the other large RNBC – Peerless. He discusses the regulatory architecture
for raising resources; the jurisdiction of the Securities Exchange Board of
India (SEBI) and other elements of the financial system. The second strand is
the story of Sahara, its promoter and the Pariwar. This strand is set in
a larger imprecise maze. The maze helped Sahara to leverage every loophole in
the system. The also has some sub-strands that do not add value to the story: The
chapter in pages 185-224 where he discusses the roles and profiles of people on
the regulatory side, is an example of force-fitting details into the book. It
makes the book look well researched and meticulous but adds little value to the
narrative.

How do
organisations like Sahara evolve and thrive? Bandyopadhyay says that Sahara “has
4,799 establishments and businesses under 16 verticals in its fold and is the
second largest employer in the country after the Indian Railways…” (p.xiv).
That a group could be so complex in its organization and so diverse in its
business ranging from retail to real estate, with a finance company in its core
could be a challenge even for financial forensics specialist. How did the
regulatory agencies allow Sahara to grow and become a case of too-big-to-fail –
moving beyond the financial sector, in a diversified set of activities? Sahara
is a case that poses challenges to arguments on convergence versus
specialization in regulatory approaches. I wonder if the financial sector
legislative reforms committee (FSLRC) report would be written differently if it’s
singular purpose was to deal with an organization like Sahara.

The book
demonstrates (a) how frail our regulatory architecture could be; (b) how a
smart business house could constantly exploit the regulatory arbitrage; and (c)
how slow the system is to plug the loopholes. The book demonstrates the
complexities in regulating a fully grown business with its complex web of
transactions like Sahara. Any inquiry or regulatory intervention on Sahara is
obfuscated two of its favourite tactics: (a) overload the regulator with
truckloads paper and (b) go to the press with full page advertisements on its
innocence. In documenting the story of Sahara, Bandyopadhyay has rightly raised
more questions about the Indian financial system and has answered lesser
questions about Sahara itself.

The details of
the Sahara story goes much beyond Sahara itself. Sahara is a case in point, but
it is a story of our regulatory and policy architecture that left enough space for
a player like Sahara and Peerless to operate, in a space that appears to be
regulated, but difficult to regulate. In the story it is only the Reserve Bank
of India (RBI) under Governor YV Reddy that comes out as a mature and patient
regulator, who is trying to fix the system, while the other regulators are
groping around on how to deal with an instrument issued in the market here, a
tax dispute there and so on. Surprisingly the Sahara also does not appear to be
as sure footed as it usually is, when it comes to RBI. This is possibly because
Reddy looked at the larger picture, more from a systemic view with Sahara being
a case in point. That may also be why Bandyopadhyay deals with Peerless in such
detail, while the book is about Sahara.

While the
regulatory frame provided Sahara to thrive and prosper, its strength was in raising
resources. Any diversified business group of that scale would have accessed the
capital markets regularly for equity and debt. Surprisingly Bandyopadhyay tells
us that only four of the 4,799 companies of Sahara Pariwar are listed and the
one time it went to the capital market for substantial funding was when the RBI
choked its milking cow – deposits raised from RNBC. This public offering was of
Optionally Fully Convertible Debentures (OFCD). If we put the sequence of
events together, it appears that this was the turning point for the business
group. Investigations started and legitimate questions were raised. Approaching
the market meant offering a prospectus with substantial amounts of data which
was subject to the scrutiny of the regulators.

The book discusses
the regulatory jurisdiction and the nuances involved in the OFCD issue and how
it started spelling trouble for the group. So, what was the source of funding
before Sahara took the public offer route? This is where we get to discuss the
opaqueness of the Indian financial system.

The source of
funding for Sahara till then was the RNBC which was providing unlimited amounts
of cash for the group to indulge in businesses as diversified as Formula One
racing, owning a cricket team, media, real estate, hospitality, financial
services and retail. The bone of contention was the source of this money. The
argument of Sahara was that these were deposits painstakingly collected by
their staff from large number of retail depositors who are very poor and were
looking at a safe and reliable place to park their savings. This is explained
by an army of deposit collection agents recruited by Sahara which takes it to
the claim of being the largest employer after Indian Railways. However, the
moment that channel is choked – we saw that the empire was in the danger of
crumbling – particularly with the fact that raising resources from the
mainstream markets appeared to be fraught with regulatory and disclosure
related risks. The entire episode pertaining to the identity of the depositors
of OFCDs indicates what Sahara was up against once it moved from its
traditional and opaque source of funding.

This takes us
back to the RNBC – which was the main source of finances for the company. There
are enough indications in the book to hint that it was difficult to identify
the depositors. There isn’t enough material to establish the widespread
perception that Sahara was funded from unaccounted finances from politicians.
If we were to give the benefit of doubt to Sahara - that it was indeed
collecting deposits from the countryside with an army of its agents; their
customers were known to the agents but were the ones excluded by the banking
system because they did not have identity papers, it brings us to a larger
question on financial inclusion – particularly on the savings side. By closing
this option, has RBI closed one option in the formal sector that the poor could
access to save their money?

We need to examine
the proposal for setting up of payment banks in this context. On the
liabilities (deposit collection) side, Sahara was like the proposed payment
banks: providing the savers opportunities to put in small amounts of savings.
On the assets side while the stipulation for RNBCs was to park 80% of the
deposits collected in safe government securities, the stipulation for the
payment banks seems that all the money (100%) has to be invested in government
securities. Sahara possibly was able to garner profits through using the 20%
buffer it had on free deposits to invest in diversified businesses that fetched
handsome profits to service the depositors. With payment banks having no head
room for managing the assets side, and with heightened regulatory requirements on
know your customer (KYC) norms applicable to the depositors, is there a
business case for the payment banks? Bandyopadhyay’s book does not offer an
insight into the business model of this structure, but at this juncture it is
important to examine the experience of the RNBCs while we make a case for the
payment banks.

The book is
lucidly written, and while there are many digressions from the core and the
narrative gets chatty at places, we could allow that stylistic freedom to the
author considering the painstaking research undertaken for this study. While it
is a well-researched book, what is unsaid seems to be much more significant
than what is said. The author is to be complimented for doing such a fine job.
We should also welcome the fact that the author settled the dispute with the
Sahara group to go ahead with the publication with a disclaimer. If that has
not happened we would have missed out on an opportunity to get this insight
into a significant player in the financial sector.

The Butterfly Defect: How Globalization
Creates Systemic Risks and What to do About it.

Ian Goldin and Mike Mariathasan

Princeton University Press, 2014

pp.296. Price not
specified.

The Butterfly Defect is a long book to make a short point. We live in a
large interconnected world, and the interconnection brings to the fore its own
risks. These risks are not to be wished away, the interconnection makes it more
and more difficult to isolate and insulate problems. In the interconnected
world the physical borders do not matter and an event in one corner of the
world can affect some other part of the world really fast. Therefore, we are
indeed living in a risky world. This world has its efficiencies, economies of
scale, a certain subversive tendency, but the downside is also enormous.

The authors choose multiple sectors to illustrate this point after laying
down the basic argument in the first chapter. The first chapter shows the
linkages, the interconnectedness and describes the nature of risks. The second
chapter picks something that we continue to experience – the effect of events
in the financial sector and how it affected the world at large. It is not just
about United States, but also looking at events in Iceland and later in Greece.
The ripples are still being felt elsewhere in the world, where our own Governor
of the Reserve Bank talks about US taper as he goes about announcing the credit
policy.

In addition to the financial sector, one other sector that sharply
illustrates the risk of interconnectedness is the health sector. A few years
ago, we experienced a global scare over Severe Accute Respiratory Syndrome
(SARS); there have been instances of large scares because of the outbreak of
Swine Flu; and economic losses due to Bird Flu. These show how pandemics just
cross borders and puts the global community at risk a result of increased
mobility across borders.

The authors illustrate other risks as well. Free movement allows the
world to achieve economies of operations, and establish clusters of specialization
leading to very high productivity. This could happen not only in services like
software, but also in the manufacturing sector. The dominance of China, Korea
and Taiwan in some sectors of manufacturing based on a cost advantage is well
known. The risks of such super-efficient clusters open themselves up to supply
chain risks. The authors illustrate how a flood in Thailand had effects on the
production of hard disk drives across the world.

In addition to supply chain risks, there are risks of infrastructure: gas
pipelines, under-sea fibre optic cables, satellites all add to the efficiency
but also open us up to great risks. There are environmental risks as well –
local processes leading to global warming, leading to a larger carbon footprint
and depletion of ozone. This aspect is discussed in detail as well.

The seventh chapter pertains to the risk that is associated with rapid
growth, fast economic development leading to increased inequality. That in
itself could be one tension, but the social risks that emanate out of
homogenization because of a dominant culture is another. While the authors move
from the very obvious risks of growth and economic development to much more
subtle risks of inequality and social risks, their argument gets weaker. The
authors are not able to communicate the immense risks that inequality brings
in, effectively. Through this chapter, they lend themselves to Jagadish
Bhagwati and Arvind Panagariya to do easy target practice.

Each chapter has one section on how to cope with these risks. These
suggestions look obvious and are not backed with a concrete framework for
implementation. These are solutions that could be provided to the world at
large, irrespective of whether the problem came from interconnectedness,
globalization or something else. Here are some of the lessons:

Lesson 1 The current global financial
regulation framework is inadequate. The solution: “Independent and yet accountable national and
supranational agencies are required and these mush have the necessary
authority and ability to oversee and promote the stable evolution of the
global financial system” (p.65-66)

The last chapter is fully devoted to managing systemic risks. The
solutions like to ones above are couched in generalities. So, the book tells us
what we already knew: the globalized interconnected world is risky. It also
brings together the nature of risks in diverse sectors which we possibly saw as
independent and unconnected events. These could be traced to a common cause of globalization.
The book identifies the obvious problem well. It attempts to look at the
not-so-obvious problem of inequity and social risks but does not analyse it
enough. It does not offer any frameworks to deal with the problems it
identifies. The net effect is that the world in general and the book in
particular leaves us with an unsettling feeling.

Thursday, December 26, 2013

Sudhir Venkatesh shot to fame with his book “Gang Leader for a Day” and
also with his contributions to the chapters in Freakonomics where he analysed the
behavior of drug peddlers and sex workers. “Gang Leader” was a departure from
the usual works of sociology - it departed from known frameworks of social
structures and frames, towards a participative ethnographic work. It was ground
breaking in many ways: because of the methods; the ethical dilemma that these
methods threw and the subject itself which looked deeply into the underground
drug economy of Chicago. This work was a result of a much younger Sudhir, not
trapped by fame of a relatively unknown student trying to get going on his
doctoral thesis.

So when Sudhir came with his next book – looking at a different trade
and a different city, he had already set the benchmark of “Gang Leader” and the
expectations were that he would transcend his past pinnacle. However, Floating
City disappoints – it is neither rich in its content nor in its insights;
leaving us to wonder whether he was a one project wonder. We hope not.

The book has its contributions. However, these pale against the
expectations based on his past work. The most significant insight we get is
that the underground economy is not restricted to the poor, but has a seamless
connection with the wealthy and the sophisticated. There are unusual suspects.
In addition we find strivers trying to move from a street-side segment of the
underground economy to the more sophisticated segments.

Readers’ dissonance about Floating City may be because of the
un-organised nature of the trade that studies. Unlike drug peddlers of Chicago,
who seem to be in a well-knit hierarchy – much like a corporate empire and
living in close proximity (of the erstwhile Robert Taylor Homes), his subjects
in New York come from smaller networks, and diverse residential settlements. In
“Gang Leader” he discovers the relations between different players after understanding
the network. Unfortunately Sudhir is lost in New York. Lost because, he is
using the inter-relations between the different sets of people he talks to, to
map the network. That is always much tougher.

Also unlike the carefree Sudhir of Gang Leader, here is a tenured
Columbia University Professor who needs to worry about his reputation. In the
earlier book, he shows the pressure to wind up his study only towards the end
of the book. Now he is no longer the rogue sociologist and very much a part of
the establishment. He has requirements to teach and publish – irrespective of
whether he agrees with the type and nature of publications that are
academically recognized and rewarded. It is evident through the book that a lot
of his own personal problems of tenure, his divorce and the professional
insecurities come in the way of the narration. He is no longer an outside
analyst – or a fly on the wall – who is looking at the situation unfold, but by
his own choice, an active participant in the deliberations.

Possibly the problem with the book lies in Sudhir’s inability to draw a
line between the sociological elements that he needs to study as an outsider
and the autobiographical elements that come in as a counter point. He could
have chosen to write the book with a greater element of autobiography. But it
would have taken a different shape. A good example of that is Aman Sethi’s “A
Free Man”. Sethi goes in as a journalist, and while understanding the poor
footpath dwellers of Delhi also narrates what it means to him. Sudhir is
hamstrung with this image of being an academic. So he unfortunately keeps
getting in his scholarly dilemmas into the narrative, never allowing the reader
to even forget for a moment that he is ultimately a sociologist and this project
is an academic work.

Studies such as this one are complex and cannot have a framework or a
premeditated script. It is almost like writing a script for a documentary – you
can only plan the subject, how you would conduct interviews, whom you would
meet. Nobody can actually write the dialogues in advance or have a clear
expectation of what emerges out the filming. When one does not have a clear
frame the danger is in wonderment - like a child in a toyshop. If every person Sudhir
meets is adding to the n (sample size) then there is a problem. Sudhir
unfortunately is a victim of his success, his image constructed in our minds, and
unfortunately, his image constructed in his own mind. This could have been a
fascinating book if only he had shed his past. It could have been as
fascinating if he had teamed up with somebody younger and unknown who could
penetrate deeper into the underground economy. Unfortunately this turns out to
be an attempt to live up to the past image and the halo created around himself.
And that he does not live up to that image leads to a book like Floating City,
which is a disappointment.

Tuesday, December 17, 2013

Self-Help
groups (SHG) as a concept have been there in existence for ages. However, SHGs,
in the arena of financial intermediation have been there for more about 25
years, starting with the early credit management groups set up by Myrada, a
Non-Governmental Organisation (NGO) based in Bangalore. However, Ajay Tankha
and other official chroniclers would record the birth of SHGs on the historic
day of 26th February 1992 when the National Bank for Agriculture and
Rural Development (NABARD) issued a ‘landmark’ circular (p.22). The
construction of history has placed so much emphasis on an official recognition
of an experiment that was in the making for five years. Therefore the year 2012
instead of being celebrated as the silver jubilee of SHG movement was
celebrated as the twentieth anniversary of issuing a circular.

Tankha’s
book is constructed on the ‘review’ of SHG movement, and performance in the
past two decades. Therefore the book is organized into factual silos: origins
of the groups; performance and growth; institutions involved; costs;
sustainability and impact. He has succumbed to the danger of this approach: of
looking at silos in detail, loaded with facts and numbers and losing the big
picture in the process - the landscape of financial inclusion. By this process,
his time marker is an official recognition, a day when SHGs entered into the
statistical reportage of the Nation.

The
tragedy of the SHGs has been the evangelical obsession with the “movement”
rather than the concept. The concept of people getting together as a group for
doing financial transactions was not new, a fact that Tankha recognizes early on.
There are informal chit funds in India operating on a similar lines. SHGs just
tweaked the model to suit its acceptance with the formal banking sector. SHGs
conceptually addressed issues that bother the bankers. They created a
collective identity for the women in the group, and gave transaction
aggregation. As it was a savings led model, it also created a transaction trail
for the bankers. This was important in the absence of a bankable collateral.

Before
this book, Tankha has worked and written on diverse issues pertaining to SHGs –
his particular contribution was in estimating the cost of promoting SHGs and
SHG Federations. We can see that the overall approach of this book is towards
evaluating the movement on financial terms. But at the end of twenty (five)
years, we should look at whether the concept is relevant, the reasons for
limited regional success and what it means to be taken over by the state. When
we look at the future directions as Tankha attempts to do, it is important to
go back to see if the base principles are in-tact.

Tankha
fails to recognize the conceptual triggers behind the growth of the movement in
a particular direction. For instance, were SHG federations necessary? While it
looks natural that as the movement grows, we need consolidation and federations
are a natural outcome. That, is the line of argument he takes. However, if we
examine it from an intermediation perspective –it does not make sense to add another
layer of costs between the bank and the ultimate customer. Aggregation of SHG
transactions at the Federation level would make sense if the spread of banking
was not deep. It would, for instance, make sense for a Kotak Mahindra Bank or a
Yes Bank. But for public sector banks having a physical presence in more than
45,000 rural and semi-urban locations it does not. It only cannibalizes the
local business through an aggregation at the regional office level and
by-passing the branch network through an alternative federation route. This takes
us to the design principles to see if they work.

The
unfortunate part of Tankha’s approach in this rather well researched and
detailed book is that he does not question the status quo. He takes facts as
they appear and chronicles them. It would have been delightful if he had looked
at each of the landmark events to build a story on how these events changed the
course of history. If he had done that, he would have re-narrated our story of innovation
that is so Indian in nature.

The
story is that this innovation did happen. The natural excitement for this
innovation should have come from the commercial world – particularly the banks
who should have engaged with this segment commercially. However, the excitement
came from the State in the paradigm of empowerment, inclusion and development.
While it made sense for SHG movement to seek the patronage of the State during
the initial phases to sell the concepts to the banking world, going forward the
basic commerce and the commercial exchanges were compromised because of the
State. Initially it started with subsidies that provided funding for building
the social architecture. But when the subsidies and intervention entered the
commercial transactions, the decline of the spirit of SHGs started. Tankha
fails to grasp this nuance.

Without
undermining his remarkable work, we need to recognize one significant gap in
the book. While Tankha locates SHGs in the world of financial inclusion, he
fails to look at some emerging trends that question the fabric of groups.
Technology led interventions and state policy is moving towards disintermediation.
The Aadhar enabled payments, the direct benefit transfers or payment of MNREGA
wages are sought to be loaded on to the individual bank account of the poor
customer. What does this do the SHGs? Is the State suffering from the schizophrenia
of the Rural Development Strategy being at cross purposes with the Financial
Inclusion Strategy? Unfortunately Tankha does not engage with this scenario at
all.

But
for my reservations about the approach of the book, this is an important
resource book for anybody interested in the field of SHG based financial
inclusion programme in India.

Mass Flourishing is a deceptive title for a remarkable book. While the
title indicates that it would throw light on innovation and job creation, it is
much larger. It covers several centuries of thought; has a range that touches
economics but moves into politics, literature and philosophy; places short term
events on a long timeline; helps understand the implications of a patchwork
over the fabric of economies. All these are packed into a tight and gripping
writing.

The book engages with the concept of a “modern economy”. How do we
achieve happiness in a just and equitable society? The process of unravelling
what a modern economy leads to a discussion of multiple economic ideas
capitalism, socialism, Marxism, corporatism. All these ideologies are discussed
in the context of economic growth, common good and happiness. While statistics
help in parameterizing, Phelps draws upon art and literature to assess how
people were perceiving the changes. These ideas are discussed in the context of
a larger eco-system. Nothing happens in vacuum – even individual excellence and
scientific discoveries and inventions happen at a time and place; the context
is as important as the event.

Look at the following quote to understand where Phelps is coming from:

“Some might think to say that gifted inventors,
even if untrained, were adding to scientific knowledge when their tinkering led
to an invention. But these inventors did not create scientific knowledge any
more than bartenders inventing new drinks create chemical knowledge: they
lacked the training to do so. An addition to scientific knowledge occurred if
and when trained theorists managed to understand why the invention worked. (It
took a musicologist to see how Bach’s cantas “worked”). (p.13)

So, what makes this modern economy? Where are the ideas coming from? Are
they from the science labs? How do ideas emerge? How do we understand the
non-pecuniary motives driving innovations? How do these ideas grow, and spread?
These are difficult questions. But in these he sees the seeds of a modern
economy, where ideas, innovation and invention were converted to economic
products leading to an explosion of material benefits. The modern economy was
about increase in productivity- resulting in fast and boundless growth. But the
question was whether growth resulted in widespread benefit? While the numbers
of rich increased, what about the wages of the unskilled workers? Were they
benefitting from the innovation and the modern economy?

Phelps connects several unrelated events to trace the evolution of
modern economy. The absolute and real increase in wages; reduction in incidence
of disease because of advancement of science (elsewhere, and a result of
international exchanges); reduction of poverty and pauperism. He then examines
urbanization. He argues that rural areas only had under employment but not unemployment.
But working for somebody, for an enterprise defined what employment was, and
also sharply defined the phenomenon of unemployment. Urbanization was on the
rise, because it was a worthwhile trade-off for the underemployed rural
populace. In understanding this, Phelps not only uses data of that era, but
also refers to Blake’s poetry and the image of “dark satanic mills”.

Urbanization was also about clustering. People went to places where
there were new ideas, new challenges; industrial agglomerations. So the quality
of life and moving out of poverty was not only the economic aspect, but the
pleasure of encountering new problems and the satisfaction of solving them. The
nuanced view he has about an assembly line is evidenced by this observation: “Charlie
Chaplin’s image of the assembly line in his 1937 film Modern Times looked more
mindless than oppressive” (p.52). Modern economy, while it brought higher
wage and better financial returns, also had associated questions on impacts on
mental stimulation.

Modern economies brought benefits in better health and longevity. Even
the less advantaged had these benefits. This led to a different perspective:
more time invested in equipping oneself and planning for a longer career. Going
to a “work place” beyond the closed community relationships led to an
“interchange” of ideas – where a large number of diverse people turned up. So
what happened to people during these changing times? Here Phelps moves beyond
data and uses literature – the ideas expressed in the works of Charles Dickens,
Mary Shelley, Emile Bronte, Jane Austen, Balzac and Emily Zola. He moves from
fiction to art and to music. The canvas gets bigger. His understanding of
economies and economics is not purely dependent on trade, economy and monetary
policy. He is questioning Ceteris Paribus (All other things being equal);
arguing that all other things are never equal; we live in a dynamic world; and
we pick up signals from multiple fields to understand the changing phenomenon
of the dominant paradigm.

With innovation, modernization, longevity and better quality of life as
a backdrop Phelps examines the other building blocks. These come from a larger
eco-system. In discussing institutions, he examines institutions of governance
(feudal systems, church, governments); institutions of justice; institutions
that grant ownership rights on property. As the world moved from production
based economies to idea based commerce, there was a need to protect
intellectual property rights. Starting with intellectual property protection
Phelps lays the foundation for modern enterprise to emerge. The emergence of
the enterprise is not a pure function of innovation and risk taking. It needs
an eco-system that provides protection for investments in ideas. This could come
through patent laws that provide exclusivity to commercially use the ideas to
reap the benefits of investments.

Just ideas and inventions do not result in economic phenomena.
Protecting intellectual property makes sense only when there is a possibility
of commercial exploitation of the idea. A commercial exploitation needs an
element of scale. It has to move beyond the individual capability. Chartered
corporations that undertook business with the backing of monarchies, laid the
framework for a corporation. Initially Charters were set up with the intention
of trade, exploration and colonization. However, as monopoly institutions with
state support, charters did not have the agility to innovate and expand the
horizons. It was a hurdle. Eventually this grew into the idea of a joint stock
company. This provided the entrepreneurs the protection of a limited liability.
The legal framework for this emerged in the United States and moved on to Great
Britain and then extending all the way to Germany and France. This was followed
up by better bankruptcy protection laws and a vibrant banking system.

On the political front, the movement towards representative democracy
provided an ecosystem for accountability. Accountability to the electorate
supported the interests of the underserved, and moved towards publicly funded
education and opened support institutions. There were downsides to this, but
the larger ecosystem for enterprise to flourish was more likely in a
representative democracy than an autocracy.

While urbanization brought about unemployment, the modern economy
brought taxation that collected money from the wealthy to provide social
security for the deprived. This brought to the fore, the question of
inclusivity. Does the modern economy and its growth provide opportunity for
everybody to get employment and a share in the economic action? Phelps argues
that if capitalism is working in the right spirit with other institutional
mechanisms fostering innovation, the answer might be yes. But most of the time
capitalism does not work the way it ought to – the governments direct the
economic space in a manner that stymies innovation and free trade. This could
happen if the state was a major actor as it were in the Chartered companies,
and it could happen when the state resorts to corporatism – an arrangement when
the state favours agreements with corporations and workers to create exclusive
rights. While Phelps does not refer to India in this context, this could have
happened in the licence raj, and might be continuing with crony capitalism.

Phelps argues that the age of innovation and mass flourishing happened
between 1820s and the 1960s (the years of the great depression
notwithstanding). He argues that this was a western phenomenon led by the
United States and followed by European nations. He illustrates why China,
though it had the ingredients of density of population, exchange of ideas,
innovation and even enterprise did not keep up as it lacked economic
institutions and economic culture (p.106).

Phelps goes on to discuss economic thought that was against the concept
of modern economy – Socialism and Corporatism. He argues that neither the
middle-income earners were pushed into the proletariat, nor did wage inequality
appear to increase (p.114). The discontent with the modern economy was with the
precariousness of jobs and wages – the episodic high unemployment and recession
led job losses in certain sectors. Phelps sees socialism as a concept with
inherent contradictions. Look at this quote of Sassoon that he reproduces:

“Socialism’s appeal, when it had one, was to say,
at one and the same time, that its mission was to transcend capitalism while
improving it; that everyone was equal by that the proletariat was the leading
class; that money was the root of all evil but the workers needed more of it;
that capitalism was doomed but the capitalists’ profits were as high as ever;
that religion was the opium of the people but that Jesus was the first
socialist; that the family was a bourgeois conspiracy but it needed defending
from untrammeled industrialistion; that individualism was to be deplored but
that capitalist alienation reduced people to undifferentiated atoms; that there
was more to politics than voting every few years while demanding universal
suffrage; that consumerism beguiles the workers but they should all have a
color television, a car and go on holidays abroad.”

Phelps goes on to discuss economic thought that was against the concept
of modern economy – Socialism and Corporatism. He argues that neither the middle-income
earners were pushed into the proletariat, nor did wage inequality appear to
increase (p.114). The discontent with the modern economy was with the
precariousness of jobs and wages – the episodic high unemployment and recession
led job losses in certain sectors. Phelps sees socialism as a concept with
inherent contradictions, examining tension between socialist values and Western
humanist values. While Phelps looks at socialism as an ideology to be debated
and critiqued, he does not think that Corporatism has strong ideological roots.
It could be the association of Corporatism with Mussolini and the fascist
regime and it could also be that Corporatism is also anti-competitive in
nature. However he engages with the concept at length, citing examples from
Europe, where it evolved, how it grew and why it was not a positive thought for
the modern economy. Phelps argues that corporatism was anti innovation,
anti-enterprise and growth. He even indicates that the reason for the decline
of the Western enterprise, particularly of the United States is because of the
modern day corporatism. While recession and slowdown is seen as recent
phenomena, Phelps traces this recession back to the 1970s.

The last section “Regaining the Modern” deals with the approach to
taxation. Low taxation, heavy borrowing – and spending – both on welfare as
well as a supply side Keynesian measure to maintain growth leading to very high
fiscal deficit was unsustainable. Not only did the State borrow, but it
encouraged corporations and individuals to borrow – in the hope that this would
lead to growth and larger tax collections. That this did not work, is there for
us to see.

The last section “Regaining the Modern” deals with the approach to
taxation. Low taxation, heavy borrowing – and spending – both on welfare as
well as a supply side Keynesian measure to maintain growth leading to very high
fiscal deficit was unsustainable. Not only did the State borrow, but it
encouraged corporations and individuals to borrow – in the hope that this would
lead to growth and larger tax collections. That this did not work, is there for
us to see. A high tax regime with a wider net gave State enough resources for
funding infrastructure and public projects. A low tax regime, wider compliance
and exemptions at the lower level resulted in an illusion of “reduction in take
home inequality” but actually reduced investments in public infrastructure
leading to the poor paying out of pocket for some services (education,
healthcare) that should have been available in public domain.

This book is vast in its expanse, deep in its insight and philosophical
in its approach. It is not only a must-read, but a must-multiple-read book. The
canvas laid out by Phelps overwhelms you, but this is by far one of the best
treatises written on the concept of a modern economy.

Sunday, June 09, 2013

Every few
years there appears a business book that dictates the discourse; changes the spoken
language and that too will pass. Business is all about winning the consumers
and outwitting the competition. This needs a sharp sense of where the world is
moving and how one could spot opportunities. Consultants are better placed to
spot these trends because their core business is in being voyeuristic about others’
businesses; understanding the levers of success and transmitting it. Gurus
attain their position because of their universality of view rather than the
specificity of a context. Ram Charan’s latest book is to be seen in this light.

The world
of business is constantly looking at markets to be penetrated, markets not
saturated, markets with purchasing power and markets with enthusiasm and
appetite translating a pent up desire into an actionable purchase. These
markets are not only to be identified but doing business in those settings is
to be learnt. Like Ruchir Sharma’s "Breakout Nations" that looked at how
economies function, and how to spot long haul performers and Rama Bijapurkar’s
“We Are Like That Only” which contextualizes the opportunity, Ram Charan’s
“Global Tilt” is designed to combine both – identity the opportunities and then
offer nuggets on how the opportunities could be encashed.

Ram Charan
identifies that the opportunity set is moving away from the North to the region
below the thrity first parallel - South. That is the Global Tilt. In this Tilt
North’s assumption is that it is moving into the so-called emerging markets
from a position of strength. This needs to be rechecked. It is somewhat similar
to the comment Muhammed Yunus made when Grameen tied up with Danone to supply
low cost fortified curd in Bangla Desh. Yunus called this Social Business and
said that Danone was convinced about the “purpose”. Somebody asked him if he
was sure that Danone was not using Grameen, he turned around and said “Why do
you think Danone is using me, and not that I am using Danone?” This is the line
of argument that Ram Charan offers: Identifying vulnerabilities and proving how
this current belief of a position of strength is really a weakness in the long
run.

This is an
interesting argument. If a company were to occupy a new market, it would need a
partner in order to understand the new territory and get feet on the ground.
The “occupier” has technology, experience and product. However, access to
markets are provided on a partnership basis with the partner with “territory”
having a major stake. While the “occupier” company looks at this as a door
ajar, to be pried open to get full access, the host actually welcomes the guest
to get access to the technology, and eventually a steep learning curve ensures
that the partnership progresses with a position of equal strength.

What Ram
Charan further states is that the governments themselves have these policies
laid out; the governments of emerging economies are smart; they will eventually
give the “occupiers” a run for their money. I am not sure that all emerging
economies, have a well thought national competitiveness strategy. As he rightly
identifies capital, human resources, and ownership of corporations is becoming
seamless; without nationality; becoming mercenary. It is natural that the businesses
move to locations that provide the best arbitrage. According to Ram Charan the
new “occupiers” are countries like China, India and countries of the South; markets
could be the universe; is something that the emerging “occupiers” the countries
from the south seem to be doing much better in regions like Africa, while it
should have been a natural destination for the traditional “occupiers” from the
North.

Basically
Ram Charan’s thesis ends there. He adds one more term repeatedly used in the
book: outside-in future-back strategy. Look at the business diapassionately and
place yourself up on a timescale and review your current. His book ends when he
proposes that economic power has shifted from the traditional regions to
emerging regions. This essence is in the first 24 pages. Beyond this he moves
on to explain the financial world to the reader, rather ineffectively. The rest
of the book is written in a somewhat preachy condescending tone which is more
of a to do and a not-to-do list. Random examples pop up every now and then to
justify and illustrate a grand universal phenomenon that he tries to explain a
concept. The book is a great example of how a good tight article for Harvard
Business Review can be pulled stretched into 300+ pages. In places the book
also becomes incoherent and verbose.

As to the
longevity of the Tilt theory, before a new fancy term replaces it – your guess
is as good as mine. Given the stature of the author, people will talk about it
for a while, before he or somebody else invents a new buzz word. My estimate is
that the Tilt theory will last about six months.

Talking about the limitations and the potential of
capitalism is the flavor of the season. The turmoil in the financial sector,
its ramification across geographies; the long road to recovery has led to
questions about the philosophical underpinnings of market-capital based model.
Conscious Capitalism is to be examined in this context.

Contemporary writings have three strands of arguments
in defining enterprises with a conscience. These strands of equitable and
humane face of capitalism had started emerging much before the crisis; but the
context for examining these models is important in the post crisis era.

The first strand does not question the basic structure
of capitalism. It accepts the philosophical underpinnings, but argues for
tweaking. The tweaking is articulated as transparency; disclosure of interests;
independent oversight; and better corporate governance practices. This strand
looks at failures as failure of governance than as an inherent philosophical
flaw.

The second strand argues for alternative forms of organization.
In the past, the alternative to capital based enterprise was co-operatives, a patronage
based enterprise. There are not-for-profit entities that do not distribute any
residual claims; not having “maximizing return on capital” as the core purpose.
A new dimension in this strand comes from Muhammad Yunus as “Social Business”
which ring fences profiteering, while allowing nominal investments to be taken
out.

Conscious Capitalism falls into the third strand that
accepts the basic framework of the capital centric model, but would want it to
be accountable on other parameters. This is the clutter of social enterprises.
Customer centricity, ecological sustainability, ethical practices, employee engagement,
and patient capital without a compromise on the financial returns are the
features of such enterprises. Depending on the type of business, entrepreneur
and investor, the focus on these capital plus factors would change.

The authors provide a framework for “conscious”
capitalism by integrating four aspects of the business: management of culture,
leadership, articulation of purpose (beyond earning profits) and integrating
the stakeholders. The basic message is that if you do no evil, your business
will survive and prosper; earn competitive returns without guilt. A large part
of the book is about the business of Whole Foods Market (WFM) and the choices
that the firm had to make at various points in time. The authors also draw from
the experiences of other “Conscious” businesses like the Tatas, Posco, Walmart,
Patagonia and Southwest Airlines. The businesses which are classified as
“conscious” businesses have had their share of controversy.

The folklore of employee centricity of the Tatas in
the aftermath of the Mumbai terrorist attack is used as an instance to show the
consciousness of the Tatas. However, Tatas are not just about Taj Hotels. A
difficult situation of larger ethical dilemma at Singur is not touched. Or that
of Posco’s land acquisition process as a “conscious” capitalist? Does Walmart’s
zero waste to landfills aspiration (p.149) make it a conscious capitalist while
literature suggests insensitive handling of workmen healthcare benefits that
were “outsourced” to the State!

The middle ground argument has thick borders between
what is acceptable and what is not. A practice could become desirable on the
basis of a strong argument. Take this quote:
“people ask us, ‘Why does WFM sell some foods that aren’t particularly
healthy?’” The justification is “Ultimately
our customers ‘vote with their money’ every time they shop. Just as, over time,
they have voted for more and more organic foods, we hope they will gradually
vote the unhealthiest foods out of our stores by choosing not to buy them”
(p.79). This is an argument that could easily be applied to Philip Morris. The
authors dismiss this “great” (as described by Jim Collins) company with the
question “what has been the net impact of
Philip Morris, the world’s largest tobacco company for much of the past
century?” (p.282). Storing not-so-healthy food in WFM is a customer choice,
while “the world is (not) a better place
because the company (Philip Morris) exists” (p.282).

While the authors sound optimistic that the future will
move towards “conscious” capitalism because of the inevitability of the reward
structure, it belies experience where WFM had to make compromises “At WFM, our salary cap has been in place
for about twenty five years (the ratio has risen
gradually over the years…. To stay reasonably competitive with the external
market”(p.94).

There are ways to make a persuasive argument. The most
impressive is to have a logical argument based on consistency. The least
impressive is the evangelical method that invokes the unknown; a sense of shame;
and guilt to convince. Unfortunately the book has more of the latter strategy
than the former. While there is a need to discuss and re-define capitalism in a
world that is getting excessively polarized, this book does not add to the
intellectual debate on the matter. It gives a series of convenient examples
retrofitted to the “Conscious Capitalism” argument. This is a problem when the
practitioner narrates his achievements and the academic takes a back seat
without distilling practices into economic arguments. The book loses because it
has more of John Mackey (co-CEO WFM) and less of Raj Sisodia (Professor at Bentley
University).

With so much of churn in the capitalistic world, it might well be the
right time to look back and wonder if capitalism has failed. Geoff Mulgan’s
book on Capitalism is set at a philosophical level. Therefore he looks at the
entire business world not only from and economic lens, but also from a moral
and ethical lens. At the same time he keeps the thought process and examples
largely restricted to the world of business, except in a brilliant chapter
where he traces how Monarchies have dissipated making way for democracies,
hinting that there could potentially be another form in which the world of business
could operate. Not, that such attempts have not been made, but those attempts
have come as a counter to what Mulgan calls as the predatory tendencies of
capitalism than the creative tendencies of capitalism.

The largest counter-capitalist thought was from Karl Marx. And when we
discuss Marx, the discourse has to be raised to a philosophical level – because
Marx transcends the world of business, government and looks at the phenomenon
from a societal point of view. While Mulgan’s book is set at a philosophical
level, it looks at capitalism as a mere tool than as a philosophy. That is
because, Capitalism itself does not transcend beyond commerce. For a large part
of the book Mulgan has put a boundary around himself in unpeeling the layers of
the world of business. I use the word “tool” deliberately, because it is only a
tool that could harm or help depending on the use we put it to. The underlying
argument in Mulgan’s book is one of acceptance of capitalism, and then
exploring how it could be saved from predators and used constructively. Look at
this quote as evidence:

“…(Marx) misread the ability of capitalism to
respond to threats and pressures, and in particular he misread how well it
would be able to spread wealth as well as hoarding it. That the distribution of
wealth was often forced on it by striking workers, or reforming governments, is
one of the paradoxes of history. If capitalism had been left to the capitalists
it probably would have destroyed itself. Instead, the capitalists were bullied into
saving themselves”(p.118-119)

The questioning of the future of capitalism is follows arguments of capitalism’s
constructiveness. Mulgan does not find an inherent design feature in capitalism
that ensures capitalists do not behave like locusts. His examples show
predatory practices like the genetically modified “terminator” seeds exist. The
technology also gets protection and it takes a long time before non-capitalist
forces (like the State) make the capitalists behave.

Clearly, what capitalism provides is a framework to do business. This
framework makes capital the central part of the business and rewards the
capital with all the residues after all other factors of production have been
paid. In a utopian world of perfect competition, there should be no excessive
rent sought by a single factor of production. However, capitalism does not
provide a fix for aberrations. That fix would either come from capitalists
themselves – firms like Patagonia, Selco Solar, Narayana Hrudayalaya which suo
motu decide to restrict the residual claims and ensure that the returns from
the business are spread more widely or from the society at large. In his
brilliant chapter “New Accomodations”, Mulgan talks about a “small town of Saltsjobaden near Stockholm
where the representatives of business, government and unions agreed to create a
society with no rich individuals but rich concerns (p.230)”. It is evident
this design initiative will more often come from outside than inside.

Mulgan concludes with a range of ideas. Some of these clearly move away
from the centrality of capital – an alternative measure of exchange that looks
at time and moves beyond money. How do we change the measure of performance?
How do we introduce multiple measures of performance? All these ideas come from
beyond the business, from the larger society of which business is a small
sub-set.

Mulgan draws from a wide range of examples which makes it such a
pleasure to read the book. He has referred to the Honey Bee network that
documents innovations, the radical positive outcomes that the unique
identification exercise in India which could have in personalizing transactions
with the government, including taxes. He also draws from a wide range of
sources, beyond business, science fiction, literature, life sciences and
sociology.

With this entire range of discussions, it is surprising that Mulgan does
not devote attention to one viable alternate business model that questioned the
primacy of capital. Co-operatives though not very successful across sectors and
geographies moved the locus away from capital to “patronage” making capital one
more factor of production with residual profits going to people providing the
service or “patronage”. Co-operatives also propogated equality of vote of all
the users without discrimination, making it possible for somebody who could be
small and marginal to have a equal say in the way the business is done. He also
does not discuss the Social Business model that is being propogated by Muhammad
Yunus which also rejects the accumulative tendency of capitalism. If Mulgan had
built many more such counter-capitalist ideas in the book, he would have had a
much lesser tentative answer to the question he asks about the future of
capitalism.

The Locust and the Bee is a brilliant book, full of great ideas,
provoking us to pause and think. He ends the book with a brilliant picture of
imagining the identity of a city. How do we define a city? Through its palaces
and forts, churches and temples, railway stations, airports and museums or the
skyline of Manhattan. If our image of USA is predominantly filled with the
Manhattan skyline, we know that Capitalism is still around.